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THE EFECTIVENES OF MACROPRUDENTIAL INSTRUMENTS AND BANKING MARKET STRUCTURE ON BANKS’ PERFORMANCE:
EMPIRICAL EVIDENCE ON EMERGING COUNTRIES
Yuli Teguh Hidayat, Tumpak Silalahi1, and Prof. Dr. Rina Indiastuti2
Abstract:
Recently, numerous Central Banks implement various macroprudential policies to complement monetary
policy that have been established as a compulsory study at the Faculty of Economics and Business. However,
macroprudential instruments are still relatively new. Its intended purpose is to achieve stability in the financial system
while monetary policy is intended to achieve the objectives of macroeconomic stability. The structure of the banking
industry affecting the effectiveness of macroprudential policy because the financial industry will respond to monetary
policy and macroprudential policy would be well responded if the banking market structure can be identified in the
early stage. Allegedly the differences that occur between the overly concentrated market structure as in the monopoly
market and vice versa in a perfectly competitive market has a different effect when testing the effectiveness of
monetary and macroprudential policies. This dissertation study aimed to explore the implications of macroprudential
policy particularly the effect of banking market structure on the profitability of banks in Indonesia and how the
interaction between macroprudential policy and market structure.
Research methodology used is based on an econometric model with the model specification and the main
purpose of research is to assess the performance of banks. There are two main models used in this study: firstly, using
a longitudinal panel OLS regression analysis with a design that is analysis of longitudinal data modeling that consist of
panel fixed effect model and random effect model is further equipped with a Hausman test. The second approach,
complementary study was conducted with the model of Vector Auto Regression Model (VAR) to test cointegration,
stationary test, Granger Causality Test, Impulse Response and Variance Decomposition.
Key word: Macroprudential policy, Banking Structure, Commercial Bank
Profitability.
1 Yuli Teguh Hidayat and Tumpak Silalahi, Student at the Faculty of Economics and Business, University of Padjdjaran,
Bandung Indonesia, Working at Center for Central Banking Research and Education, Bank Indonesia, corresponding author: [email protected] or [email protected] 2 Co-author, lecture in Economics and Business Faculty, University of Padjdjaran, Bandung Indonesia, corresponding co- author: [email protected].
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MACROPRUDENTIAL INSTRUMENTS EFECTIVENES AND BANK MARKET
CONCENTRATION ON BANKS’ PERFORMANCE:
(EMPIRICAL EVIDENCE ON INDONESIAN BANKING FIRM PROFITABILITY)
1. INTRODUCTION
Research on the banking industry became the topic of many resercher in depth at
present, it is inseparable from the phenomenon of the global financial crisis of 2008,
which makes a variety of changes to banking authority expects the model to corporate
banking which is sustainable and beneficial for the economy.
The emergence of bank failures due to the 2008 global crisis in the world banking
industry, that indicated from a number of banks in developed countries (developed
countries) to bail out, making the formulation of resilience in the banking industry is
indispensable. The resilience of the financial system of the pressure his own crisis
(financial resiliance) is influenced by various factors.
One of the factors the durability depends on the structure of the market owned by
a Contracting State on its financial system, are more oriented to financial or domination by
capital markets (Capital market orientation).
Indonesia's financial system is dominated by the banking sector which is reflected
by the bank's market share is more dominant than the capital markets and non-bank
financial institutions, therefore, highly relevant microeconomic deepening bank to do.
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Emerging countries such as Indonesia have a very much interest on banking sector since
bank interest margins as a measure of financial intermediation costs is particularly
pertinent in the absence of developed capital markets and the small presence of non-bank
financial institutions, households and firms largely depend on bank financing.
The role of macro prudential instruments belief to stabilize the financial system,
however on the individual banking institution those policy can affect the banking
profitability. On the other side, the effectiveness of macroprudential policy depend on the
bank market structure.
According to Arreguy et all (IMF WP -13/167), implementing macro prudential
will effect on the costs arise from an increase in the cost of intermediation and its effect on
long-run output. Even though, the benefit is derived from the resilience of the economy
from the policy measure—a reduction in the probability of a crisis and output losses in the
event of a crisis.
2. MOTIVATION OF THE STUDY
Study about macro prudential instruments become a new policy trend particularly
since the global financial crisis during 2008’s beside monetary policy that already long
exist in the economic theory. However, it is still premature to know precisely how the
interaction between monetary policy and macro prudential policy influence the business
strategy of the banking industry.
Based on explanation above, this research is intended to study the things as
follows:
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1. To review and analyze the impact on Indonesian macro prudential policies on
performance of commercial banks in Indonesia.
2. To study the impact of market power or market concentration on commercial bank
profitability.
3. To examine the relationship between economic cycle with commercial banks
performance.
4. To review and analyze interaction between market power or market concentration
and macro prudential policy in conjunction with the profitability of commercial banks
in Indonesia.
To achieve those objectives, research methodologies developed in this paper based on the
econometric model as a primarily tool using quarterly commercial bank data since 2007
until recently as a compliment to descriptive and statistical analysis.
3. THEORETICAL BACGROUND
Study of literature and research on micro-economic banking mostly refers to the
contribution Brucker and Klein (1971) and Bernard Shull (1963). At the level of
microeconomics, a production function of goods is relatively easy to explain but in the
production function model in the banking services industry is not as simple as the
production of goods. That's because the production on a bank deposit collection services
and disbursements of public funds which of course is more complicated to measure.
Several literature studies try to explain the level of productivity in the banking balance
sheet by way of diagnosis (balance sheet) a simple bank among others: Xavier et al (2008),
Mankiw, NG (1986) and Mishkin (2010), as follows:
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Assets Liabilities + Capital
Reserves Deposits
Loan Equity
On the assets side of the balance sheet there is a Reserve bank (R) is the difference between the
volume of deposits received by banks as well as the volume of loans disbursed by the notation
(D_it-L_ (it)). Reserve bank owned which symbol can be classified into two types, namely
Statutory Reserves (usually not given interest) with the notation SR with i interest rate and t
the period of bank portfolio position in the interbank market M(t) with the following model:
+ .......................................................... (1.1)
From the point of understanding or definition of a bank as a financial institution described
as an example, by Xavier et al (1998, p.1) that defines the operations of the bank as a
financial institution that guarantees loans and accept deposits from the public. While, Rose
and Hudgins (2005) defines a more comprehensive bank: first, the economic functions it
serves, both, the services it offers its customers and third, the legal basis for its existence.
Monetary authorities generally require commercial banks keep a portion of the public
funds in the bank as statutory reserves (reserve requirement) to be deposited in the
central bank in the form of cash or securities in vault. The amount of the reserve
requirement set each monetary authority and RR policies affect the ability of banks to lend
that ultimately affect the performance of the bank. Why banks must keep some funds in
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the banking industry has a RR for different legality of other non-bank industry is given the
mandate / business license to collect public funds (Giro, deposits and savings).
Because the banking industry is not controlled by a particular company, then the Monti-
Klein models easily explain models of imperfect competition (Cournot) among a number
of banks N is more a portrait of reality. To simplify the analysis, it is assumed there are N
number of banks that have a similar cost function, and linear:
( ) 1.2
The link between market structure, conduct and performance is described by the
company two paradigms is still a debate among academics. The first paradigm is
Hyphotesis Structure Conduct Performance (SCP) and the second, Hyphotesis Relative
Market Power (RMP). Traditional SCP Hyphotesis found the level of bank profitability is
affected by the level of market domination which concentrated market structure
(monopoly and oligopoly) with a market share effect on performance. While the RMP
Hyphotesis found diversified banking products became the market power which in turn
have an impact on improving the profitability of banks. Lubis (2012), examined the
behavior of Indonesian banks in influencing the price that shows how much market power
that empowered as an indicator of the level of competition in the market. The findings of
the study was the level of competition in the Indonesian banking credit market is still
quite high but can not be categorized as a perfectly competitive market. Parera (2010)
(market concentration bank in Sri Lanka), concluded in his research on SCP, which is
concentrated on bank structure impact on bank powers to set interest rates on loans and
higher and lower interest rates on deposits.
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4. RESEARCH METHODOLOGY
There are many factors that affect the performance of the banks. The factor such as
internal and external factors would be investigate for this research. Some research on the
impact of external factor on Net Interest margin (NIM) for Indonesian Financial Sector had
been done in a partial such as the effect of GDP and Inflation. Hoewever, the effect of
macro prudential instruments on NIM still rarely since the data is unpublish by the
Central Bank.
Furthermore, the model developed in this research based on econometric as follows:
Panel 1 Equation:
Panel 2 Equation:
Panel 3 Equation:
Description:
SRR = Riil Reserve Requirement Ratio
DLTV = Loan to Value Dummy
GDP = Growth Domestic Product
Infl = Inflation Rate
MS = Market Share Power
CR = Concentration Share Power
Aset = Bank Asset
CAR = Capital Adequacy Ratio
CIR = Cost to Income Ratio (Efficiency Perbankan
NPL = Rasio of Non Performing Loan
NIM = Net Interest Margin
= + + 𝐡 + + + + +
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Growth DPK = The Growth of Commercial Bank Funding.
The analysis will be performed refers to two types namely panel data modeling residual
Fixed Effects Model (Fixed Effect Model (FEM) and Random Effects Model Model (REM).
Electoral most appropriate model among the models of Fixed Effects or Random Effects Model is
based on the consideration that the model improper could cause bias. Therefore, using Hausman
test will examine the best model which is FEM or REM.
As a proxy for measuring the performance of the banking industry that bank
profitability that need to be investigated whether macro prudential policy and the level of market
share (market power) of a bank relative to the effect on the profitability of the banking industry.
In academic circles, there is still debate whether the market share (level of competition) lead to
market stability (stability Concentration hyphothesis) or market share actually cause market
instability (Concentration fragility hyphothesis). If the level of mastery of a dominant market
instability (fragility) and decreased levels of efficiency and profitability of the banking structure of
the Indonesian Banking implications settings need to be cautious.
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No Variables Description Source of Data
Expected
Sign.
1 Riil Reserve
Requrement The change of Reserve Reserve Requirement Ratio. Bank Indonesia(BI) -
2 LTV'S Dummy Event Study, reguation of Loan to Value =1 for the
period. Q-II 2012 since policy implementing and =0
other period. BI -
3 Market Power Level of market share compare to bank industries BI +
4 Concentration
(CR4,CR11) Concentration of 4 firms to industry BI +
5 Bank Asset(Asset) Total Aset of Firm
Bank Scope Bureau Vandijk +/-
6 Bank Capital Capital of bank proxy by Capital Adequacy
Ratio(CAR) BI +
7 Bank Efficiency (Cost to Income Ratio), notation: CIR BI -
8 (Credit Risk) Non-Performing Loan to Total Loan, Notation: NPL BI -
9 Net Interest margin Net Interest margin, Notation: NIM BI +
10 Deposit Growth Growth of bank funding BI +
11 GDP Economic Growth IFS +
12 Inflation Inflation IFS +
5. DATA AND STATISTIC DESCRIPTION
The data in this study will be obtained from a variety of sources of data that is owned
by Bank Indonesia (Indonesian Banking Directory), the privately run Bank Scope Bureau
Vandijk, Blomberg and data from the International Financial Statistics (IFS). By using
longitudinal panel regression as a primarily tool based on quarterly commercial bank data since
Q1 2005 until Q-IV 2012, allows this research to avoid multicolinearity test.
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6. STLYLIZED FACTS
For region 5 Southeast Asian nations (ASEAN-5), the net interest margin is the highest
Indonesian thus reflecting the relatively low efficiency of Indonesian banks in the ASEAN
region. Indonesia's banking performance compared to the performance of banks in the
Southeast Asia region and with other continents as depicted on the chart.
GRAFIC: AVERAGE Return on Aset banking industry based on Regional Source: The
Grafic: Average Net Interest margin To 10 Banks in ASEAN-5
1.67
1.06
1.94
2.12
1.93
1.58
0.09
1.51
0.98
1.31
0.59
1.13
0.6
2.01
0.35
0.22
1.25
0.36
-0.5
0
0.5
1
1.5
2
2.5
Africa Asia-Pacific Caribbean Central andEasternEurope
Central andSouth America
Central Asia Europe Middle East North America
2012 2011 2010
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7. RESULTS AND SUMMARY
The profitability of bank is influence by net interest rate margin, operational expenditure,
policy rate and credit risk. The economic growth have significant effect statitistically on
profitability on lag 3 that mean the commercial bank will respon to the economic cycle within
3 quarter.
In addtion, this paper provides some conclusion and policy recommendation, firstly, as
Bank Indonesia is a legal authority of monetary and banking suversion till now, so Bank
Indonesia needs to understand the determinants of bank performance. Secondly,
investigating the impact of macro prudential should aware with the market share of the each
industry. Failure to understand the relationship the interaction between macro prudential
instruments and market power will pose a risk to financial stability. These conclusion have
policy implications both direcly and indericly on designing macro prudential instruments.
Therefore, coordination and joint research between the monetary and fiscal policy will
benefit to provide a finacial stability.
Based on Panel 1 equation as describing on research methodology, the result of eviews-8
as follows:
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14. Kaminsky dan Reinhart (2000), Bank Lending and Contagion:Evidence From the Crisis,Department of Economics, George Washington University,Washington DC 20052.
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16. Sabine Herman and Dubravko Mihaljek (2010), The Determinants of Cross-Border bank flows to emerging markets: new empirical evidence on the spread of financial crises, BIS Working Papaers No.315.
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